As private credit has ballooned and its economic underpinnings have grown more shaky, LPs are scrutinizing managers more closely than ever. In: differentiated strategies and conservative underwriting. Out: low-margin loans in crowded sectors that encourage looser underwriting.
In private credit, “Everything tastes like chicken,” joked Nayef Perry of Hamilton Lane at the SuperReturn Private Credit conference in New York last week. “Everyone is looking for differentiation.”
LPs and GPs at the conference discussed their strategies for private credit, co-investment and secondaries in a fast-evolving private credit market. After decades of low interest rates and relative stability, the economic environment for non-bank lenders has grown volatile. Some borrowers that loaded up on cheap debt are now struggling with higher interest rates and an uncertain economy.
Chris Creed, a partner with Galvanize’s credit and capital solutions strategy stood up earlier this year, suggested that sustainable private lending may be removed from the issues afflicting the broader “race to the bottom” in the syndicated loan market.
“Reading the headlines, it’s either the golden age of private credit, or, ‘Oh my God, we’re about to enter the next financial crisis,’” he said. “And I don’t think that that has anything to do with the kind of private credit that [we] are talking about.”
Galvanize’s credit and capital solutions strategy provides bespoke financing for companies and projects in North America and Europe pursuing clean power and the energy transition more broadly.
“If you can be a little thoughtful, a little creative, you can actually get better covenants, you can get better collateral packages, and you can get better returns, and make the impact as well as the return.”
Cash flowing
One sector where investors see opportunity for growth is sustainable infrastructure and the energy transition. “We believe there’s a massive market opportunity set,” said Joshua Kim of the California State Teachers’ Retirement System, or CalSTRS.
Kim, who leads private credit for the pension fund’s $1.3 billion Sustainable Investment and Stewardship Strategies, is looking to get a jump on cash-flowing sustainable assets to boost returns while longer term equity investments, which make up two-thirds of the SISS strategy, play out. That means scooping up private credit secondaries and other mature assets.
“Because we’re a young portfolio, we’re very much in the J-curve and in need of both [net asset value] and yield to offset some of our equity strategies,” said Kim of the sustainable investment strategy launched in 2021.
CalSTRS partnered earlier this year with a large fund manager that invests in clean energy private credit via its insurance unit. In addition to investing, CalSTRS also bought up more than $100 million in existing deals from the fund manager’s insurance balance sheet.
“We are doing more sustainable and climate late-stage buyouts that are mature businesses and cash flowing,” said Kim.
Co-investments
LPs have embraced co-investment strategies for private credit and equity to lighten their fees and goose returns. But that’s not the only factor.
“It’s a great tool for us to get to know a manager who might not yet be raising a fund, or might be raising a first fund that is not quite a fit with our client demand for the moment,” said Giulia Roverato of Wilshire Advisors, a New York-based firm that advises on more than $1.5 trillion in institutional assets.
“A co-investment has been a great way to look at how they source, understand how they do their diligence, understand how developed their infrastructure is, and what monitoring capabilities they have,” she said.
Suyang Kim of the South Korean sovereign wealth fund KIC, also sees dual benefits from co-investments. “We’re trying to generate the alpha with the coinvestment, and by making commitment to their existing funds, we can evaluate how they do” and what kind of pipeline they have, Kim said.
KIC, with more than $227 billion in assets, is increasingly focusing on managers’ workout capabilities as more loans go sour, Kim said.
With defaults growing, private lenders’ valuations may not reflect the true state of their borrowers, what some researchers have dubbed “mark-to-myth.”
Jay Clayton, who heads the Department of Justice’s Southern District of New York, warned this week that private lenders will come under more scrutiny. The public will “want to know that private marks, where there’s liquidity offered or an asset value-based fee to be paid, are good marks,” he told Bloomberg. “I expect we will have more to do in areas of our private markets.”
The volatility and heightened scrutiny “sets up the framework for conservative lending strategies, of being incredibly prudent with your diligence and your underwriting standards,” said Scott Baskind, chief investment officer and head of global private credit at Invesco.
“Manager differentiation has been quite challenging for LPs and others to distinguish,” he said. “As we go forward in 2026 and 2027 that’s going to start to see a lot more separation.”
Emerging managers
That presents openings for new managers with experience and fresh ideas.
Wilshire Advisors, for example, seeks out new managers who are experts in their niche, have a competitive advantage, or have developed better credit products.
“We try to partner with managers before other people do. We think that is when they have the highest potential and the best ideas,” said Wilshire’s Roverato. “That makes their trajectory more sustainable. It allows us to look at very interesting strategies.”
There’s plenty of room to grow loan portfolios. Some $650 billion in equity has been channeled for climate related investments, noted John Herstritt, who heads sustainable and impact investing at GCM Grosvenor, a $90 billion institutional asset manager for large institutions around the world. In comparison, just $50 billion is dedicated to climate-focused private credit.
“I think we’re in that phase of innovation where you’re seeing different types of managers show up with different things,” said Herstitt of GCM Grosvenor.
He rattled off a number of specialized credit strategies in the climate sector. One manager has carved out a leadership role securitizing residential mortgage-backed solar loans and is now moving into home energy efficiency loans. Another is focused on very short duration project financing, or bridge loans, for sustainable projects. “They have a very deep track record of doing that, and very low loss ratios,” he said.
With new strategies and specializations, Herstitt said, managers must make a credible case for themselves as well as for their strategies.
The huge mismatch of supply and demand, says Herstitt, means that, “For those that know what they’re doing, there’s a lot of excess alpha and return in the space.”
